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February continues positive start to 2019 for energy: After January’s rally, February was a more modest yet still positive month for the energy markets. Oil prices ended the month at $57.22/bbl, up $3.40 from last month, and contributed to the outperformance for S&P Energy.1 HY Energy gained 1.43%, buoyed by commodity prices as well as the sustained rally in the high yield market. While midstream indices lagged large-cap equities and credit in February, the AMEIX has been the top-﻿performing energy benchmark YTD.1 The 26% increase in crude prices in 2019 has been driven partly by OPEC production cuts, which have been implemented as promised. OPEC has cut supply by more than 2 million barrels/day, or 6.3%, since the end of the year. Meanwhile, Russia has indicated it too will follow through with cuts. It will be important to monitor inventory stockpiles to determine whether OPEC+ cuts are enough to balance out U.S. production, which continues to hit record highs. A drawdown of 8.5 million barrels in the last week of February suggests that, at least for now, the answer is yes.1

Q4 continues solid run of financial performance for midstream: Midstream companies continued to deliver positive earnings during Q4, finishing off a stellar 2018. Over half of the constituents in the AMZX beat consensus EBITDA estimates, while 36 of the 37 companies maintained or increased dividends QoQ.2 For the AMEIX, nearly two-thirds of companies beat estimates, while all but one firm maintained or grew distributions.2 For much of 2018 we believed fundamental performance of midstream companies belied their volatile market performance, and so far in 2019 it seems investors may finally be catching on. We believe market volatility has been driven not necessarily by fundamentals but by a restructuring of the space, which includes elimination of incentive distribution rights (IDRs). IDRs are a legacy characteristic of MLPs that entitled the GP to a higher proportion of distributions as they increased, which incentivized some GPs to aggressively increase yield beyond what would be considered prudent. Most firms have eliminated such IDRs, either by converting to a C-corp or simply striking them from the partnership agreement (68% of AMZX constituents have eliminated IDRs).3 This trend is universally seen as a positive but has caused distribution increases to moderate, an uncomfortable trend for some income-hungry investors. We believe the elimination of IDRs across the space will lead to more sustainable distribution growth over time, and that market performance may stabilize and improve as investors get more comfortable with these changes.

KEY TAKEAWAY

Energy markets continued to bounce back from Q4 lows.

Oil prices rose moderately as OPEC has started to implement planned production cuts.

Q4 midstream earnings were generally solid and investors may finally be getting comfortable with the space.

Index descriptions: Alerian MLP Index is the leading gauge of energy Master Limited Partnerships (MLPs) and is a float-adjusted, capitalization-weighted index, whose constituents represent approximately 85% of total float-adjusted market capitalization. Alerian Midstream Energy Select Index is a composite of North American energy infrastructure companies and is a capped, float-adjusted, capitalization-weighted index, whose constituents are engaged in midstream activities involving energy commodities. ICE BofAML U.S. High Yield Energy Index is designed to track the performance of U.S. dollar-denominated high yield rated corporate debt publicly issued in the U.S. domestic energy market. S&P 500 Energy Index comprises those companies included in the S&P 500 that are classified as members of the Global Industry Classification Standard (GICS) energy sector.

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